Each earnings season, The Energy Strategist focuses on quarterly results in the oil services industry, paying particularly close attention to the subsequent conference calls hosted by the management teams of the four largest companies: Baker Hughes (NYSE: BHI), Halliburton (NYSE: HAL), Schlumberger (NYSE: SLB) and Weatherford International (NYSE: WFT).
This quarterly ritual has two purposes:
- Services firms stand to reap the benefit of declining production from the giant onshore oil fields that for decades have supplied much of the world’s oil. Not only do these firms offer technologies that maximize production from mature plays, but the complex unconventional and deepwater oil fields that the world relies on for supply growth require a wider range of high-margin services. As a rule of thumb, the more difficult it is to produce oil from a specific reservoir, the bigger the profit for the services firms involved.
- Focusing on the Big Four services companies, all of which boast substantial international operations, provides an excellent overview of emerging developments and trends throughout the exploration and production industry. This invaluable intelligence is useful for identifying smaller, pure-play names that offer exposure to powerful growth trends.
Over the past several quarters, the oil services industry focused on the slow recovery in international markets, as spending and activity levels have yet to return to pre-crisis levels. Once producers ramp up investment in international oil projects, multinational oil services firms will be firing on all cylinders.
But one story was lost in the shuffle: Speculation about a potential recovery in the deepwater Gulf of Mexico. Roughly one year after the disastrous Macondo oil spill, producers and oil services firms have expressed hope that activity in the region could pick up in 2012. The deepwater Gulf of Mexico has been the only meaningful source of US production growth over the past two decades. Although output from onshore shale oil plays has expanded significantly over the past two years, the industry would welcome a resumption of activity in the deepwater Gulf.
As you’ll recall, the Obama administration first issued a ban on drilling in the deepwater Gulf in late May 2010, a decree which the courts ultimately struck down. On July 12, 2010, the administration successfully placed a moratorium on deepwater drilling, which was lifted three months later, though what many in the industry described as a “permatorium” remained in place up until last month. The Bureau of Oceanic Energy Management, Regulation and Enforcement (BOEMRE), formerly the Mineral Management Service, was slow to approve permit requests for new deepwater wells.
In the months after the Macondo oil spill, BOEMRE issued a series of Notices to Lessees (NTL) that outlined new rules for operating in the deepwater Gulf. The first of these NTL requires operators to receive third-party certification that the blowout preventers on their rigs are in working order, while subsequent notices require prospective drillers to explain their plan for controlling surface oil spill or subsea leak.
In July 2010, industry heavyweights ExxonMobil Corp (NYSE: XOM), Chevron Corp (NYSE: CVX), ConocoPhillips (NYSE: COP) and Royal Dutch Shell (NYSE: RDS.A) formed Marine Well Containment Co. (MWCC), a nonprofit organization whose members account for roughly 70 percent of the drilling activity in the deepwater Gulf of Mexico. At this point, the MWCC has developed an interim containment system that works in waters of depths up to 8,000 feet and can accommodate up to 60,000 barrels per day of liquid. The group is also at work on expanded containment system with a capacity of 100,000 barrels per day and a maximum water depth of 10,000 feet.
Meanwhile, Helix Energy Solutions (NYSE: HLX) has developed the Helix Fast Response System (HFRS), which utilizes two existing vessels and will be available for charter to members of Clean Gulf Associates, an industry trade organization similar to the MWCC.
BOEMRE has signed off on both of these technologies, opening the door for new permits. On Feb. 28, 2011, the regulator approved the first post-moratorium deepwater drilling permit, allowing Noble Energy (NYSE: NBL) to drill a bypass. In March, Royal Dutch Shell had the distinction of earning the first permit for new deepwater exploration.
Since the moratorium was lifted on Oct. 12, 2010, BOEMRE has approved 12 revised exploration plans from a backlog of roughly 35. However, the agency has yet to approve any initial exploration plans.
In particular, Halliburton has benefited from this uptick in permit approvals. During the company’s conference call to discuss first-quarter earnings, CEO David Lesar highlighted the company’s success in winning business in the Gulf:
Another very positive development in North America is the issuance of 10 drilling permits [now 12] in the Gulf of Mexico. If you look at the service contracts associated with these wells, Halliburton will be performing approximately 30 percent of the drilling services and 40 percent of the completion work on them. This is actually higher than our historical market share…
We feel we’ve kind of hit the bottom on the Gulf of Mexico, with the increased permits. While it’ll take some time, we still expect that as the year progresses, the Gulf of Mexico will start getting back to work. And that comes at a nice, consistent margin that historically has been quite good. So that will add to the mix favorably.
Schlumberger CEO Andrew Gould noted during the Q-and-A porition of the company’s investor conference that an uptick in activity in the Gulf of Mexico could tighten pricing in international markets, though he acknowledged that the Gulf would need to attract 20 or so vessels. Questions about whether the $75 million liability cap will remain in place are another uncertainty that will weigh on a recovery in the deepwater Gulf, particularly among smaller operators. As Gould told attendees at the company’s 2011 investor conference:
Bottom line: Although activity in the deepwater Gulf is unlikely to return to pre-Macondo levels for some time, a gradual recovery could provide upside for oil services firms in 2012. Nevertheless, this trend, along with the battle over whether BOEMRE should hold scheduled lease sales of acreage in the deepwater Gulf, bear watching. Keep abreast of the best investment opportunities in the deepwater Gulf and in international markets by signing up for a free trial of Elliott Gue’s The Energy Strategist.
I agree that once–by the way, not just our customers but when the regulator and our customers work out what a permit should be and how you get one, yes, the permits will go quite fast, I don’t think that’s the question at all. The question is, how are they going to define a satisfactory liability cap that does not exclude everyone except the supermajors from the Gulf of Mexico, but is high enough to keep the general public and Congress happy, with the amount of liability that companies are on the hook for when they drill into the deepwater Gulf of Mexico? And until that question is settled, I don’t think a lot of our customers are going to be in a hurry to look for permits. So I think that is a much more fundamental question to our customers today than the mechanics of the permits; it’s just no one is talking about it or not very much.
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